2. Here are book- and market-value balance sheets of the United Frypan Company:

Book-Value Balance Sheet

Net working capital $20 Debt $40

Long-term assets 80 Equity 60

$100 $100

Market-Value Balance Sheet

Net working capital $20 Debt $40

Long-term assets 140 Equity 120

$160 $160

Assume that MM's theory holds except for taxes. There is no growth, and the $40 of debt is expected to be permanent. Assume a 35% corporate tax rate.

(a) How much of the firm's value is accounted for by the debt-generated tax shield?

(b) What is United Frypan's after-tax WACC if rdebt = 8% and requity = 15%?

(c) Now suppose that Congress passes a law that eliminates the deductibility of interest for tax purposes after a grace period of 5 years. What will be the new value of the firm, other things equal? Assume an 8% borrowing rate.